Software: Not the same game anymore
Software used to be a wonderful business. It did have many of the attributes of strong competitive advantage. It tied users with high switching and search costs therefore enjoying a great pricing power. Software companies were able to up sell users on ongoing maintenance contract in perpetuity as a percentage of the original sale. Those days are over.
The Internet is turning itself to be the computer for all. It does not matter if you are a small business or large organization, your software use will change. Open source and software as a service applications has almost replaced all kinds of software applications.
Consider our company, we have cut drastically all types of software purchases compared to few years ago. Please consider:
- We began a year ago to use Google Docs as our email server, office tools and as collaboration and knowledge management platform.
- As for our Customer Relationship Management we use Salesforce.com.
- Accounting is done through online packages.
- Open source for many development components.
What is the effect of such transformation:
- reduction of need for capital expenditure, improving our cash flows
- reduction of our technical resources to maintain infrastructure to host all these application
- ability to scale operations easily
- we can level the playing filed with large organization by using similar technologies to manage our business.
In an opposite dynamic to the unbundling of media on the Internet, software and hardware are getting bundled. Software and hardware have converged and bundled by Saas companies. Saas companies are providing businesses with the application and the hardware along with the technical expertise to manage them. Businesses will only focus and concentrate on their core functions of converting raw material to products that customer wants rather than worry about supporting functions like IT.
Google, Amazon and Salesforce are becoming a utility companies distributing computing power to users in same fashion power companies are distributing electric power to households and businesses. Companies like Google, Amazon and Salesforce are investing billions to construct data centres with huge computing power to sell and distribute to the masses, similar to constructing power plants.
If you look at Salesforce.com financials you will see very similar return on sales and investment to utility companies. The reason is Salesforce and Google are not the software company like Microsoft and Oracle in its day, but it is a capital intensive business. It needs large sums of money to build computing capacity and real estate to be able to be successful in the Internet time.
Microsoft and Oracle who are traditional software companies will face an uphill battle going forward. The culture of software is so entrenched to change easily. I do not see the merit in investing in software companies anymore, but I like utility companies like Google and Amazon.